Cincinnati Bell's pending purchases of Hawaiian Telcom and OnX show the company is looking to use acquisitions to enhance its fiber reach and the burgeoning cloud and enterprise network consulting business lines.
As a regional telco that has amassed sizeable fiber assets, the company’s acquisitions were something many in the investment community like Morgan Stanley were not expecting. Many had thought Cincinnati Bell could have been a potential acquisition target itself.
“Given its fiber dense geographic footprint, we had considered Cincinnati Bell to be more of a strategic asset than an acquirer,” Morgan Stanley said in a research note. “Therefore, we were surprised to see the company announce two separate transactions in July for total consideration of $850m.”
These acquisitions give Cincinnati Bell scale from a fiber and business consulting point of view—two of the service provider’s key growth priorities.
Upon completing its acquisition of Hawaiian Telcom, the service provider’s total fiber network size will exceed 14,000 fiber route miles.
By acquiring OnX Enterprise Solutions, a technology services and solutions provider in North America and the United Kingdom, for about $201 million in cash, Cincinnati Bell will enhance its CBTS division to respond to more cloud service opportunities.
“These transactions represent Cincinnati Bell's vision to create two standalone $1b+ businesses that capitalize on the growing demand for fiber and technology consulting services,” Morgan Stanley said. “CBB is aiming to further distance itself from legacy wireline companies who trade between ~5-7x EBITDA, and move towards fiber/cable companies, who trade between ~9-11x.”
Wait and see approach
While Cincinnati Bell has found a new method to evolve from being just another regional telco, the challenge for the company will be in proving it can successfully complete and integrate these assets into its fold.
This thesis comes amidst challenges faced by its peers Frontier, Windstream and CenturyLink’s recent acquisition efforts.
“CBB is seeking to transform itself via M&A,” Morgan Stanley said. “The market has punished other wireline M&A efforts (see Frontier, Windstream, CenturyLink), so M&A execution will be key to Cincinnati Bell's success.”
Morgan Stanley said that Cincinnati Bell could face various potential risks: a slowdown or decline in revenues, a deceleration in Fioptics growth or a large increase in cable competition in Cincinnati and Hawaii.
CBB's ultimate success will depend on its ability to sustain LSD legacy revenue/EBITDA growth, while integrating two business that will roughly double the size of the company.
“While we expect Fioptics investments to continue to propel revenue/EBITDA growth, further deceleration could weigh on the multiple,” Morgan Stanley said. “Our $9 bear case values the wireline business at 6x EBITDA and the CBTS business at 6.5x. Putting these scenarios together, we see a wide risk reward that we believe merits our wait-and-see approach.”
Split coming?
Upon completing these two deals, Cincinnati Bell will instantly double the size of the company, raising speculation that it could divide itself into two companies—one that provides fiber and copper-based services to businesses, providers and residential customers and a cloud services company.
“By adding scale to its IT services business (CBTS), Cincinnati Bell hypothetically could be setting the foundation for a future split,” Morgan Stanley said.
Each of these company segments continued to progress during the third quarter.
Cincinnati Bell told investors during its third-quarter earnings call that it is on track to reach about 80%-90% of its customer base in Cincinnati with its fiber-based Fioptics service within the next few years as the telco continues its aggressive fiber build-out initiative.
During the third quarter, Cincinnati Bell had passed a total of 564.7 locations with its Fioptics service. On a year to date basis, the telco has passed 31,300 new addresses with Fioptics and said it's on track to reach 35,000 new addresses for the year.
However, IT services and hardware revenue remained flat sequentially at $96 million, and down $27 million year-over-year.
Despite the near-term revenue challenges, the service provider said previously that it is seeing new SD-WAN and UCaaS opportunities. It noted that the declines reflect customers’ shift to cloud services like UcaaS, a challenge faced by not only Cincinnati Bell, but also its larger counterparts like CenturyLink and Windstream.